UNIT III-COST ACCOUNTING

Chapter I COST SHEET

Cost Sheet is a statement which presents detailed information relating to the various stages of
cost. It also shows the total cost of the product manufactured during a particular period of time.
Thus, the cost sheet is prepared for a particular period of time monthly, quarterly, yearly etc.

Objectives of Preparing a Cost Sheet:

A cost sheet is prepared for:

(i) The total cost and cost per unit of the product can be ascertained;

(ii) It helps the management to fix up the selling price on the basis of the cost per unit of the
product after charging certain percentage of profit on cost;

(iii) It also helps the management presenting a comparative study of current cost with the exis-
ting cost per unit;

(iv) After proper comparison the management can take the corrective measures;

(v) It helps the management while formulating suitable production policy;

(vi) It is very helpful to submit a price quotation for tenders; and

(vii) It also helps the management by supplying suitable information for management control.

Method of Preparation of Cost Sheet:

The initial cost made for manufacturing a product, i.e., raw material, labour wages and other
production-related expenses, is termed as prime cost.

a) Prime Cost = Direct Material + Direct Labour + Direct Expenses.

The works cost is calculated by summing up the prime cost with the factory overheads and
simultaneously adjusting the opening and closing stocks of work in progress.

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 b) Works Cost = Prime Cost + Factory/Indirect Overheads

The cost of production includes all the direct and indirect cost, including the material, labour and
other expenses, i.e., production cost, factory cost and office or administration cost.

c) Cost of Production = Works Cost + Office and Administration Overheads

The final value of a product or service can be determined after adding all the selling and
distribution expenses to the cost of production of goods sold. The formula to find out the total
cost or cost of sales is:

d) Total Cost or Cost of Sales= Cost of Production + Selling and Distribution overheads

If sale value is given, then calculate Profit or loss = Sales – Total Cost.

A cost sheet is a useful tool for the managers to keep control over the business expenses and cost
of the products or services.
In large organizations, cost statements play a vital role in keeping track of multiple components
of costs incurred at different stages and departments including production, factory, office, selling
and distribution.

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 Chapter II: Process costing

Process costing is the type of costing applied in industries where there is continuous or mass
production. The necessity for compilation of the costs of a process or a department for a given
period, as distinct from the cost of a whole job or a specific batch of production units, has given
rise to the concept of process cost accounting. There are many industries engaged in continuous
processing in which the end products are the results of a number of operations performed in
sequence. In such industries, it is necessary to apply process costing.

Process costing is suitable for a large number of mining, manufacturing and public utility
industries like mines and quarries, cotton, wool and jute textiles, chemicals, soap making, paper,
plastics, distillation processes, e.g. alcohol, tanning, oil refining, screws, bolts and rivets,
canning, food products, dairy, and electricity and gas undertakings.

Features of Process Costing:-

1. The production is continuous and the end product is the result of a sequence of processes.
2. The product is homogeneous and the units product are identical and standardized.
3. The sequence of operations for processing the product is specific and predetermined.
4. The finished products of one process works as raw material for the next or process until
completion.

Difference between process costing and job costing:

S.N. Basis of difference Job costing Process costing
1 Cost computation Costs are computed for each job Costs are computed for
separately each process over a period
of time
2 Cost unit Cost unit is a job Cost unit is a process
3 Nature Each job may be different. Production Production is continuous.
is not continuous
4 Supervision and Greater supervision and control by the Comparatively less control
control management is required is required since the work
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 in processes gets
standardized.
5 Completion of job Completion of job is necessary for Completion of jobs is not
computation of cost of the job once the awaited. Cost per unit is
job is completed all costs are added to computed by dividing the
ascertain the total cost of total cost by process output.
6 Specific orders Job is executed against orders Goods are for mass
consumption and they may
be produced on a
continuous process.
7 Transfer of cost There are usually no transfers from one As a product moves from
job to another unless it is necessary to one process to another,
transfer surplus work or excess transfers of cost from
production. process to process are
made.
8 Work in progress There may or may not be any work-in- Production being
progress at the beginning or end of an continuous there is usually
accounting period. some work-in-process at
the beginning as well as at
the end of the accounting
period.

Process costing
Process costing is the type of costing applied in industries where there is continuous or mass
production. The necessity for compilation of the costs of a process or a department for a given
period, as distinct from the cost of a whole job or a specific batch of production units, has given
rise to the concept of process cost accounting. There are many industries engaged in continuous
processing in which the end products are the results of a number of operations performed in
sequence. In such industries, it is necessary to apply process costing.

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Process costing is suitable for a large number of mining, manufacturing and public utility
industries like mines and quarries, cotton, wool and jute textiles, chemicals, soap making, paper,
plastics, distillation processes, e.g. alcohol, tanning, oil refining, screws, bolts and rivets,
canning, food products, dairy, and electricity and gas undertakings.

Features of Process Costing:-

5. The production is continuous and the end product is the result of a sequence of processes.
6. The product is homogeneous and the units product are identical and standardized.
7. The sequence of operations for processing the product is specific and predetermined.
8. The finished products of one process works as raw material for the next or process until
completion.

PROCRSS LOSS OR WASTAGE AND GAIN

a) Normal process loss and abnormal process loss
b) Abnormal Loss or abnormal wastage
c) Abnormal gain or abnormal effective or abnormal profit

Normal process loss and abnormal process loss

Normal loss means the usual percentage of wastage arising in a particular process or operation .
it is unavoidable because of nature of the material or the process. It normally includes units
withdrawn from the process for test or sampling.

Abnormal Loss or abnormal wastage

Abnormal spoilage or defective work may arise in a process due to unforeseen factors. The cost
of such abnormal loss is not included in the cost of the process but the average cost of the lost
units is charged to an Abnormal Loss Account which is credited with the scrap and closed to the
Profit and Loss Account. Thus, in computing the abnormal loss, scrap value of the abnormal lost
units will be ignored but in working out the loss for charging to Profit and Loss Account, this
will be taken into consideration.

Abnormal gain or abnormal effective or abnormal profit

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More output over the expected or normal output realized is called an abnormal gain. Abnormal
gain arises because of an abnormal effective in the use of raw material or efficiency in
performance so it is known as abnormal effectively.
Sometimes, when the actual loss in a process is less than the anticipated loss, the difference
between the two is considered to be abnormal gain. The value of the abnormal gain is calculated
in the same way as described above for abnormal loss and is credited to an Abnormal Gain
Account which is ultimately closed and transferred to costing Profit and Loss Account. The scrap
value of the normal anticipated loss in the process where abnormal gain occurs is credited to the
process account with the result that the net debit to the process is the cost of abnormal gain less
the value of scrap for the normal loss.

Accounting of Inter-Process Profits:-

Inclusion of inter-process profit creates complications in the accounts. As the internal profits
remain merged in process stock, work-in-progress, and finished stock suitable adjustment is
required to be made in the Balance Sheet in order to exclude such unrealized profit.
When inter-process profit is included in the accounts, it is advisable to have three columns in the
ledger to indicate the cost, profit, and the total. This facilitates the calculation of the profit to be
provided for inclusion in closing stock in each process and in the final finished stock.
Reconciliation of cost and financial accounts
1) Estimates and actuals: estimates or standards can be nearer to the actual but in most cases
they cannot be the same. The cost account is bound to be different from the profit shown by the
financial accounts.
The important items of costs that differ from the financial books to cost books are
 Direct materials
 Direct labour
 Overheads
 Depreciation
2) Valuation of stocks:

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  Raw materials: in financial accounts stock of raw material is valued at cost or market
price whichever is less, while in cost accounts cost can be valued on the basis of FIFO or
LIFO or any other method.
 Work in progress: it may be valued at prime cost factory cost or cost of production. The
most appropriate mode of valuing is at factory cost in cost accounts. in financial accounts
work in progress may be valued after considering a part of administrative expenses.
 Finished goods: under financial accounts stock of finished goods is valued at cost or
market price whichever is less. In cost accounts finished stock is normally valued at total
cost of production.
3) Items included in financial accounts only:
 Appropriation of profits: e.g. Provision for taxation, transfer to reserves, goodwill, and
preliminary expenses write off etc.
 Purely financial charges e.g. Losses on sale of investments, penalties and fines expenses
on transfer of companies’ office.
 Purely financial incomes: e.g. Interest received on bank deposits, profit made on the sale
of investments, fixed assets, transfer fees received etc.
4. Items included in cost accounts only:
 Charges in lieu of rent where premises were owned.
 Depreciation on an asset even when the book value of the asset is reduced to a negligible
figure.
 Interest on capital employed in production upon which no interest is actually paid.
5) Abnormal gains and losses:
Abnormal gains or losses may completely be excluded from cost accounts or may be taken to
costing profit and loss account. In financial accounts such gains or losses are taken to profit and
loss account.

Please refer class notes for Format of contract account, balance sheet, process account etc.

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Normal profit:  is an economic term that describes when a company’s total revenues are equal
to its total costs in a perfectly competitive market. NP is included in the costs of production
because it is the minimum amount that justifies why the firm is still in business.
In economics, normal profit is the minimum compensation that a firm receives for operating. The
compensation is higher than the opportunity cost that the firm loses for using its resources
effectively and producing a given product. If a firm’s profits are lower than its revenues, the firm
incurs losses. It must meet a minimum threshold to stay in business.
Furthermore, because the normal profit is equal to zero, it doesn’t mean that the firm is not
profitable. The NP compares the effective use of the firm’s resources to its revenues.